Global Economic Recovery Too Reliant on Central Bank Liquidity, Warns the IIF

Political and policy uncertainties have intensified in the last month, strengthening the headwinds against the nascent global economic recovery, warns the Institute of International Finance.


Central banks have committed themselves to do ‘whatever it takes’ to stabilise financial markets and economies, but political deadlock represents a risk to this stabilisation, according to the IIF.


The IIF notes that the critical problem resulting from prolonged political stalemate is that essential policy reforms could be delayed – with the consequence that wider investor confidence may be undermined.


In its March edition of the Capital Markets Monitor (CMM), the IIF says that much of the recovery so far has in any case been heavily reliant on ‘easy money’ conditions fostered by central banks. These conditions – quantitative easing, very low interest rates – cannot last forever, but the risk is that financial markets have become addicted to them. The fact that the Dow Jones Industrial Average rose to a record high this week is more a reflection of these relaxed international monetary conditions than a signal of strong recovery in the ‘real’ economy.


The report points out: “The longer central bank liquidity is relied on to hold things together, the more excesses and distortions are being accumulated in the financial system. An eventual unwinding of these excesses will become a destabilizing risk event.”


“Policymakers need to be more attuned to the unintended consequences of their actions and must communicate clearly their long-term intentions with regard to monetary conditions," says Hung Tran, First Deputy Managing Director of the IIF. "This would help lessen the risk of large swings in financial markets.”


The IIF report identifies four major uncertainties: the difficulties posed by the hung parliament in Italy, following that country’s recent elections; the ramifications of the U.S. ‘sequester’ and the sharp divisions within the FOMC over whether or not to sustain QE3; Japan’s efforts to overcome 15 years of deflation; and the subterranean risks to China’s apparently successful ‘soft landing’.


Japan’s decisive action to try to end its long period of deflation is to be welcomed – a strong Japanese economy will benefit the global economy, after all, the report says.


Over in China, inflationary pressures have diminished, reducing the need for tight monetary policy. This should enable GDP growth to settle around the 7.5% official target. However, price rises in some of China’s real estate markets remain frothily elevated.


New measures – including increased down payments for house purchases and a 20% capital gains tax on property – will help cut some of the speculative froth. Of greater concern is the rapid expansion of total social financing, driven by credit extension through non-bank channels and growing by 50% (on a year-on-year basis) to more than RMB1.7 trillion at the start of 2013. This kind of rapid credit growth has in the past normally presaged a future rise in non-performing loans.

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